If the U.S. Senate Was a Hedge Fund, How Would It Do?

Answer: Not very well...

By: Shane Copsey, MeiJade Hsu, and Athen Pham
CMSC320 - Introduction to Data Science, University of Maryland, Fall 2021, John Dickerson

For this analysis, our team answers the question:

How well do U.S. Senators trade? Do they consistently outperform the S&P 500 index?

Using publicly-available data from 2012-2021, we construct a portfolio that simulates Senators' stock trades (buying and selling of stocks) over this 9.5-year period and measure its performance against the S&P 500 index.

The S&P 500 index is the best-known indicator of the U.S. stock market's performance, measuring the value — and thus the performance — of the 500 largest stocks in the U.S., so much so that it is often referred to simply as "the market." The 500 companies whose stocks are included in the S&P 500 are very well-known companies that we frequently encounter in our day-to-day lives:

SP-500-logos.jpeg

Many investors measure professional money managers' performance against the S&P 500. The thinking goes that an investor has 2 mutually-exclusive choices:

  1. Invest their money with a professional money manager, or
  2. Buy an exchange-traded fund (ETF) that tracks the performance of the S&P 500 (the market).

If the professional money manager can't perform better on a percentage basis than the S&P 500, then the investor should just buy the S&P 500 ETF since they'd make more money that way and at a lower cost and risk. Professional money managers charge fees for managing investors' money and can make riskier investments in things like private equity. Therefore, to make it worthwhile for investors to accept a higher cost and risk by investing their money with them, professional money managers need to perform better on a percentage basis than the market (expressed through the S&P 500).

Here's a chart of the S&P 500's value at the end of each trading day from 1950-2016. One way to easily interpret the chart is: If you'd spent a handful of dollars to buy a single share of an S&P 500 ETF in 1950, you could sell that 1 share for $2,000 in 2016:

sp.png

Studies have consistently shown that most professional money managers underperform the S&P 500 — over a period of 15 years, only 5% of professional money managers managed to beat it. Therefore, if we find that Senators have outperformed the S&P 500 over the past 9.5 years, then our finding would be significant since it would show that Senators — many of whom are lawyers and businessmen, not money managers — are better at investing than 95% of professional money managers, which would be an incredibly rare and impressive achievement indeed.

The question would then be: How can Senators be above-average at investing?

Insider trading and the STOCK Act

Although [insider trading](https://en.wikipedia.org/wiki/Insider_trading) — trading a company's stock based on material, nonpublic ("insider") information about the company — has been illegal and punishable by fines and/or imprisonment for most private citizens in the U.S. since 1934, it was not illegal for members of Congress until 2012. The Stop Trading on Congressional Knowledge [(STOCK) Act](https://en.wikipedia.org/wiki/STOCK_Act) was passed by Congress and signed into law by President Obama on April 4, 2012 to ban insider trading among members of Congress.

Specifically, the act prohibits members of Congress and other government officials from using, for personal benefit, insider information that they acquired through their government positions. This means that if a member of Congress acquires information that may positively impact a company but has not yet been disclosed to the public, then they cannot buy that company's stock until the information that they acquired becomes public. And if a member of Congress acquires information that may negatively impact a company whose stock that they own but has not yet been disclosed to the public, then they cannot sell that company's stock until the information that they acquired becomes public. The act also requires all members of Congress to publicly disclose any financial transactions (mostly the buying and selling) of stocks, bonds, commodities, futures, options, cryptocurrencies, and other securities within 30-45 days of the transaction.

In the nearly 10 years since the STOCK Act became law, however, stock trading by members of Congress has repeatedly caused controversy and raised ethical concerns. In 2020, a major insider trading scandal occurred when 6 Senators sold stocks after attending a confidential briefing on the coronavirus outbreak in January 2020, potentially avoiding losses when the stock market crashed in March 2020. In 2021, Business Insider identified 127 current members of Congress who had either personally or whose staffers had violated provisions of the STOCK Act:

Business Insider STOCK Act Investigation.png

Before the STOCK Act made insider trading by members of Congress illegal, members of Congress had performed exceptionally well compared to the S&P 500. A 2004 study in the Journal of Financial and Quantitative Analysis found that Senators outperformed the S&P 500 by an astonishing average of 12 percentage points per year (or 1 percentage point per month) during a 6-year period in the bull market of the 1990s. This means that if the S&P 500's value increased by 10% over 1 year, then the value of a portfolio consisting of all trades made by Senators during that year would increase by 22%.

Senators didn't just beat an already high-performing market: They also beat corporate insiders (people who were trading their own company's stock) — who outperformed the market by an average of 6 percentage points per year — and U.S. households — who underperformed the market by an average of 1.4 percentage points per year. Senators also appeared to know exactly when to buy and sell stocks: They would buy stocks just before the stocks would suddenly outperform the market by more than 25%, and they would sell stocks that had been beating the market by about 25% for the past year just when the stocks would fall back in line with the market's performance. The study's researchers suggested that Senators knew when to buy and sell stocks because they had access to information based on their government positions that other investors didn't have — in other words, they were engaging in insider trading.

Therefore, another question that our analysis will help answer is:

Is the STOCK Act preventing U.S. Senators from benefiting from insider trading?

If we find that Senators continued to outperform the S&P 500 from 2012-2021, after the STOCK Act was passed, then we may have evidence that the STOCK Act didn't achieve its goal of preventing Senators from benefiting from insider trading. On the flip side, if we find that Senators didn't outperform the S&P 500 from 2012-2021, then we may have evidence that the STOCK Act did prevent Senators from benefiting from insider trading.

To answer this question, we'll treat the Senate as 1 cohesive unit. We'll download data on all of the stock trades that they've disclosed since the STOCK Act was passed in 2012 and use Python to construct a portfolio that simulates their trades (buys and sells) over this 9.5-year period. This means that we'll buy the same amount of the same stock that they bought on the same day in the past and sell the same amount of the same stock that they sold on the same day in the past. Then, we'll convert the portfolio into an index that we'll compare with the S&P 500 index to see whether Senators performed better than the S&P 500 on a percentage basis in the 9.5 years since the STOCK Act was passed.

Importing and cleaning the data

We download 4 datasets. For each dataset, we download data from July 25, 2021 (when the first trade was disclosed under the newly-enacted STOCK Act) to December 8, 2021 (when we were writing the code for this project):

  1. A CSV of all transactions made by Senators from SenateStockWatcher.com, a free website maintained by members of the public who compile transactions disclosed by Senators into CSV and JSON files. On the API page, under the "Bulk Downloads" section, click on the "Download" link in the "All Transactions" row whose file type is a CSV.
  2. A CSV of the daily closing prices and other data of all stocks traded by Senators from Compustat, a research-grade database that is well-known among academics and professionals in the financial world. We received access to Compustat through an educational license. Members of the public can query APIs maintained by third-party websites including TradingView and Polygon, although they may have to pay for a subscription.
  3. A CSV of the daily closing values of the S&P 500 index from the Nasdaq website, which is maintained by the Nasdaq stock exchange, the 2nd-largest stock exchange in the world (behind the New York Stock Exchange) and where many well-known tech companies like Google, Apple, Facebook, Amazon, and Microsoft trade.
  4. A CSV of the daily closing values of the Nasdaq Composite from the Nasdaq website. The Nasdaq Composite measures the value and thus the performance of almost all stocks that trade on the Nasdaq stock exchange. We compare the Senate's performance against the Nasdaq since other 3rd-party analyses suggest that members of Congress buy and sell companies in the information technology sector the most frequently.